Bonds Trends Report

9 min read

All Systems Go For Public, Private Bonds

The planets are all lined up for tax-exempt affordable multifamily bonds right now, for both public offerings and private placements. That’s the unanimous conclusion reached by a panel on the Tax Exempt Multifamily Bond Market at the recent Summer Institute of the National Housing & Rehabilitation Association.

Rates on tax-exempts versus taxable executions “continue to get stronger,” according to R. Wade Norris, partner at Washington, DC-based Norris George & Ostrow PLLC and panel moderator, who said some “wonderful circumstances” are at work currently.

Norris noted his then seven-attorney law firm last year was involved in the financing of more than $3 billion in private placements and over $1 billion in private offerings, out of an estimated $21 billion of total tax-exempt multifamily bond and loan volume and said he expects it will do even more this year.

Broad Muni Market Overview; Numerous Positive Changes on the Buy Side
Karl Hummel, managing director at RBC Capital Markets, giving the “big picture” overview, said there has been “a basic fundamental shift on what our buyers are looking at” as “people start to do more unique things.”

In interest rate moves since August 2020, the Treasury market has risen, and so have municipals, but the ratio of where municipal market data (MMDs) are “is getting lower and lower and lower” according to Hummel, making for “really crazy” ratios.

“These are ratios we’ve never seen before, and it’s pretty much the same for five-, ten-, and 30-year maturities.

“The combination of low ratios and low rates really has our investors looking at alternative finance solutions,” he said. “They’re looking for any sort of yield they can find.”

Another factor is huge money inflows, he said. “So, it is sort of a perfect storm here. If you see how much money is coming into the municipal space, it’s just tremendous. They have to put this pile of money to work.”

Big Muni Bond Inflows
To illustrate the big increase, for the week ended July 7, Lipper reported a municipal bond inflow of $2.3 billion, up from just $832 million the week before.

Alternative finance sources are much more popular, he said. Before, “We probably had a handful of people in the industry that would do this. The muni buyers are real dinosaurs.” Now, things are different.

An example he gave is forward bonds. “The arbitrage accounts figured out the math. They would buy forwards. Then they would sit on the forwards. They would hedge them up. When they would become regularly settled bonds, they would sell them to my traditional muni buyers.”

Now, he said, “Investors are saying, ‘why am I letting these guys be the buyers? Why don’t we look under the hood and take that incremental yield?’”

Bottom line, we have customers that are involved in forwards. The other thing we are looking at is Cinderella bonds. And I have customers that are talking about purchasing drawdown bonds.”

Hummel said he has seen a huge change in fund behavior in the last couple of years, “even more so since the pandemic.”

Low Muni Rates Produce a Long-Awaited Affordable Workforce Housing Model
Alex Zaman, a managing director at Citigroup Global Markets Inc., briefed the meeting on the tremendous recent interest in limited public offerings of “high-yield” unrated bonds issued by California’s Joint Powers Associations (JPAs), which enable the JPAs to move apartments into public ownership, triggering real estate tax relief and enabling the JPAs to make the housing more affordable to the workforce segment.

“We now have a bond-financed workforce housing program that works exceptionally well,” he said. What happens in sum is a city or municipality offers an abatement in taxes in return for reduced rents. The JPA acquires ownership of the multifamily housing, assumes governmental authority at the time of bond issuance, restricts income to renters at the 80 to 120 percent workforce area median income level, and caps rents at 30 to 35 percent of those levels.

The city enters into a Public Benefit Agreement, whereby the city and other taxing entities receive all the surplus revenues that flow down when a property is sold or refinanced. The city does not incur any administrative fees nor are there any credit implications, making it an attractive option. The city then has a couple of options. Zaman said in Year 15 the city can purchase the property itself, force the sale of the assets, pay off the bonds and receive the net proceeds, refinance the bonds and take possession of the property, or it can pay off the bonds entirely and leave the property to the developer.

The bonds, Zaman said, are typically unrated tax-exempt municipal bonds, no equity, no subsidies beyond the tax abatement. “A number of the deals we’ve seen have had multiple senior tranches, and we’re starting to see some bespoke structures that include mezzanine or true subordinate debt.”

Zaman called these JPA financings “an elegant structure” and said a lot of California municipalities are starting to take advantage of them. They have worked best in small and mid-sized cities, he said. Larger cities “are still very much a work in progress.”

Usually, the JPA deals have involved the acquisition of existing multifamily market-rate Class A properties, with more of them on the newer side, having been constructed in the last 20 years. But he thinks eventually there will be opportunities for older properties and potentially even new construction.

Unrated Bonds, but Acting Like Rated Ones
In this market, “These bonds are trading like A-rated securities, even though they are unrated,” Zaman concluded.

A specific recent JPA transaction he worked on is Moda at Monrovia Station in Monrovia, CA, 20 miles east of downtown Los Angeles. “We issued about $118 million of bonds for this property, 251 Class A luxury multifamily units, loaded with amenities, directly adjacent to a railroad station and has transit-oriented development (TOD) written all over it.”

The city and renters both benefited from this, Zaman said. The property tax given up is about $200,000 per unit, but the rental reductions came to about $560 million per unit, meaning about $20 million in net savings over the life of the bonds. Renters at 120 percent AMI got an eight percent discount, 100 percent AMI residents got nine percent and 80 percent AMIs saw a 25 percent discount.

More Than $2.5 Billion in Volume
Norris, whose firm has represented Citi and RBC and other clients in a number of these financings said, “Think about what a remarkable development this is! This is 100 percent financing to create high quality, desperately needed affordable workforce housing in high-cost rental markets where many of these residents would otherwise have to live 20, 30, 50 miles or more away from their jobs. The industry has talked about affordable workforce housing for years. Using this structure, California has just produced over $2.5 billion of this financing in the last two years alone!” Both Zaman and Norris said that they believe this success has implications for other markets as well.

Low Muni Rates Have Also Supported Other Public Offering and Private Placement Structures
Greg Goldberg, director at RBC Capital Markets, pointed to a different bond mechanism in use at Salem Heights, a Massachusetts project sponsored by Preservation of Affordable Housing (POAH), which priced in June, financed by a $32.1 million publicly offered forward Fannie Mae M.TEBs with three-year forward and 18-year term, as achieving a very low cost of capital. It also provided higher proceeds of $3.9 million, outweighing negative arbitrage of $1.5 million. M.TEBs stands for mortgage-backed security as tax-exempt bond collateral.

The all-in pay rate was estimated to be between 80 and 92 basis points lower than comparable agency executions, he said.

Another unusual transaction done by RBC last year was The Bosco in Berkeley, CA, to build 15 units, including 12 market-rate and three affordable, using “recycled” bonds for “a little more creative execution.” RBC found a bond of the perfect size and these recycled bonds were tax exempt with no Low Income Housing Tax Credits involved “to achieve a very competitive cost of capital.”

This created affordable housing in a high-cost area just across from the Berkeley campus.

RBC has also worked with nonprofits to sell unrated bonds across the country at a very low cost of capital. “We’re seeing a lot of activity in that space,” he said.

FHA and Rural Development Taxable Loans Combined with Short-Term Cash Backed Tax Exempt Bonds Still Exceptionally Strong
The final panelist, Kelly Boyer, managing director of Rose Community Capital, spoke about federal agency executions in the multifamily space, particularly the Federal Housing Administration and Rural Development, calling the agency space “a very effective platform.” She concentrated on discussing the FHA 223f “heavy” loan and the familiar FHA 221(d)(4), which she said was good for urban infill. The 223fs do not trigger Davis Bacon wage requirements and there is no longer a three-year waiting period for these executions after a prior financing.

On the RD side, she touted the benefits of the USDA Section 538 guaranteed rural rental loan for projects located in designated rural communities.

These loans are eligible for packaging into Ginnie Mae securities, which are 100 percent guaranteed by the federal government and AAA rated and are sold in the taxable markets. These structures offer 35- or 40-year loan amortizations with no balloon, and no new project underwriting following rehab or completion of construction. Stated mortgage rates can now fall as low as three percent or a bit lower for FHA 221(d)(4) financings and below 2.5 percent for 223fs. Moreover, Boyer indicates that processing times of 120 to 180 days are being achieved in a number of markets, making these strong executions for these types of loans. Goldberg added that the coupons on the short-term tax-exempt bonds sold to meet the 50 percent test in these financings are so low (now 20 to 30 basis points), that bond side negative arbitrage on these deals has all but disappeared.

Concluding Overview
Norris reminded attendees that we saw major decline in interest rates through last summer, with the ten-year Treasury yield declining 80 percent from a yield of 3.25 percent in October 2018 to 0.54 percent in August 2020. Norris stated: “This was a huge wind at our backs on the debt side of these financings, producing additional loan proceeds at a rate of over one percent additional proceedsper month during this two-year period. (Moving from a 35-year loan amortization to 40 years produced another five points.) We’ve now given back about 40 percent of this general decline in rates, with the ten-year Treasury yield at about 1.50 percent. But because of the strong and growing demand for tax exempt municipal bonds, the debt side executions on these financings have held up extraordinarily well over the past year, and we believe that the muni market will continue to strengthen and provide further support for these financings through the end of this 2021 and beyond.”

Mark Fogarty has covered housing and mortgages for more than 30 years. A former editor at National Mortgage News, he has written extensively about tax credits.